The Pensions Regulator has directed defined benefit trustees to focus on the affordability of payments into their schemes by sponsoring employers, urging collaboration to link business recovery to increased member security.
The watchdog’s annual funding statement is a response to the onset of a sharp recession caused by the coronavirus lockdown, with impacts felt in scheme portfolios, deferrals of contributions, and the long-term health of sponsors.
While the guidance encourages a flexible approach to triennial valuations and recovery plans, it cautions that companies pausing contributions should not restart dividend payments to shareholders until they have put their pension schemes back on track to meet their long-term goals.
The regulator now views the use of covenant advice as a “comply or explain” requirement for schemes – and encourages trustee boards to scenario plan both pandemic outcomes and various levels of Brexit-related economic disruption.
TPR’s chief executive, Charles Counsell, said: “At the end of December we were seeing a general improvement in funding levels, compared with the previous three years, but the situation now will be very different for many schemes due to the Covid-19 crisis. However, we don’t yet know the full impact the crisis will have on the pensions landscape.”
Trustees need to think about what the impact of this transaction or request will be on members. It’s easy to forget that in a benign environment
Alex Hutton-Mills, Lincoln Pensions
He urged schemes and employers to pay close attention to guidance the watchdog has already released, which discusses topics including the granting of three-month contribution holidays and protection of members from a mounting scams threat.
“What is clear is that Covid-19 is testing employers and trustees like never before, and it is vital that they work together collaboratively. We are clear that the best support for a pension scheme is a strong employer, and so we are here to support both groups in our role to ensure savers’ retirements are protected,” Mr Counsell said.
The regulator’s statement outlines general principles to be followed by all DB trustees, but it also includes recommendations for those faced with the prospect of completing March valuations.
Schemes may choose to delay assumption-setting until they have a clearer understanding of market returns and the impact of Covid-19 on sponsors and longevity.
But they should forge on with other steps such as preparing and validating data, or reassessing the robustness of their investment strategies and governance. TPR instructs trustees thinking of bringing the date of their valuations forward to seek legal advice, with experts telling Pensions Expert that this would likely be viewed as feigning ignorance of the current economic situation.
Recovery plans likely to grow
When technical provisions are agreed and recovery plans are in place, companies are likely to have longer to pay off their DB debts than had previously been envisaged.
The regulator itself has stressed the importance of employer sustainability, and Calum Cooper, a partner at Hymans Robertson, said that simply backloading recovery plans of a similar length is unlikely to be best for either scheme or sponsor.
Instead, he encouraged “creative thinking” to find solutions, suggesting that a non-negotiable core contribution schedule could be coupled with optional accelerations if companies recover quickly and would like to recommence payouts to shareholders.
“If the company suddenly starts to improve more quickly, then we would like to participate in the upside,” Mr Cooper said.
He praised the regulator’s insistence on collaboration, adding: “Now is not the time to be adversarial in any way. It limits creative problem solving, and in times of stress creativity is both hard and at its most valuable.
“A strong and healthy covenant is key, and that may require short-term concessions like suspending contributions (provided it is equitable vis-à-vis shareholders, for example), potentially in exchange for security, negative pledges and enhanced information sharing, for example,” he said.
No let-off for trustees
While the funding statement stresses the importance of collaboration, it also takes a hard line on employers hoping to resume “business as usual” without sharing this upside with scheme members.
Trustees should be vigilant against forms of “covenant leakage” where recovery plans are long, the regulator warned, including cash pooling, intra-group lending, and excessive pay for executives, among others. Once the company’s liquidity, and the affordability of its pension obligations, have been “largely restored”, dividend payments may begin again.
The regulator also took its chance to call out schemes running inappropriate risks. While schemes with small allocations to equities and high hedging levels have fared well through the recent market volatility, those exposed to the stock market have suffered.
Mr Cooper said that many schemes still take unconscious interest rate and inflation risk, while he estimated that half of schemes have actually undertaken the contingency planning recommended by the watchdog.
“If these risks were considered in an [integrated risk management] framework, they should have contingency plans in place, which we expect to be implemented where possible. Where this is not the case, trustees and employers will need to consider how far they may have strayed from their longer-term objective and develop strategies to put them back on course,” the statement reads.
Long-term funding target remains
Pre-empting the focus of its now-extended DB funding regime consultation on cash flows and maturity, the statement instructs trustees to view funding and investment through this prism – ensuring that employers have time to make good the shortfalls that may appear if schemes continue to pursue risky strategies.
Mercer calls for six-month DB contribution holiday
The government has been called on to take “urgent action” and implement a six-month contribution holiday for defined benefit pension schemes, in a bid to allow sponsors to keep their businesses afloat.
Recent market turbulence has refocused minds on risk, according to Alex-Hutton Mills, managing director of covenant advisory Lincoln Pensions. While he said scenario planning cannot predict the future, taking advantage of executives’ current need for relief to have frank discussions can ensure schemes are “match fit” for future disruptions.
While the best support for a DB scheme remains a healthy sponsor, “trustees need to think about what the impact of this transaction or request will be on members”, he said. “It’s easy to forget that in a benign environment.”
